UK Loan Conventions Supporting Slides - Bank of …

[Pages:22]Working Group on Sterling Risk-Free Rates Detailed Loans Conventions

Published in September 2020 - Updated in March 2021

Not for wider circulation

Contents

#

Agenda

1

SONIA Loans Market Conventions Overview

2

Recommended Convention - Lookback without Observation Shift1

3

Alternative Convention - Lookback with Observation Shift2

5

Lookback without Observation Shift1 vs with Observation Shift2

6

Floor Approach for Legacy Contracts

7

Cumulative vs Non Cumulative Rate and the Proposed Rounding Approach

Page No.

3-4 5-8 9-14 15-16 17-20 21-22

The overall objective of the Working Group on Sterling Risk-Free Reference Rates (the "Working Group") is to enable a broadbased transition to SONIA by the end of 2021 across the sterling bond, loan and derivative markets. This will reduce the financial stability risks arising from widespread reliance on GBP LIBOR.

The Bank of England and the Financial Conduct Authority ("FCA") are each ex-officio members of the Working Group. The views and outputs set out herein do not constitute guidance or legal advice from the Bank of England (including the Prudential Regulation Authority ("PRA")) or the FCA and are not necessarily endorsed by the Bank of England (including the PRA) or the FCA.

1 Lookback without Observation Shift is also known as the Observation Lag convention 2 Also known as `Interest Period Weighted Observation Shift'

SONIA Loans Market Conventions - Overview

Summary of the recommended SONIA Loan Market Conventions (To be read alongside the Working Group statement)

1. SONIA remains the Working Group's recommended alternative to Sterling LIBOR, implemented via a compounded in arrears methodology, and loan markets should now move consistently towards this.

2. Use of a Five Banking Days Lookback without Observation Shift is recommended as the standard approach by the Working Group. This aligns with the approach recommended by the Alternative Reference Rate Committee for US dollar loan markets and in the Working Group's view is most likely to be made rapidly available. Whilst this approach is the recommendation, where lenders are also able to offer lookback with an observation shift this remains a viable and robust alternative.

3. Where an interest rate floor is used, the Working Group recognises that it may be necessary to apply the floor to each daily interest rate before compounding.

4. Prepayments. The Working Group recommends that accrued interest should be paid at the time of principal prepayment.

SONIA Loan Market Conventions and Implementation Approaches

Loan Conventions

Implementation Approaches

Interest Methodology

Interest Calculation

Lookback/ Lag Days Rounding

Day Count

Recommended Convention

Compound in Arrears

Alternative Convention

Lookback without Lookback with Observation Shift1 Observation Shift2

5 Banking Days SONIA 4 DP Actual/ 365

Other variables as required

Recommended Other Considered

Approach

Approach

Notes

Compound the Rate

Compound the Balance

? Both calculate the same interest except for intra interest period event such as loan trading activity.

? Compound the rate aligns to the current pro-rata interest distribution.

Non Cumulative Rate Method 3

Cumulative Rate Method

? Though Cumulative and Non Cumulative Rate method should calculate the same interest amount where the rounding method is consistent, the Non Cumulative Rate method is preferred for loans as it better supports intra interest period event such as loan trading activity, to distribute interest to the lenders on a pro-rata basis (see page 22)

Round Cumulative Rate, do not round Non Cumulative rate

Do not round the Compounded rate

?

The recommended approach will ensure the calculation of interest amount using Cumulative and Non Cumulative rate is the same. (see page 22)

1 Also known as `Lag' 2 Also known as `Interest Period Weighted Observation Shift'

3 Preferred where rounding method is consistent to calculate the same interest amount as Cumulative Rate Method (see page 22)

SONIA Loans Market Conventions - Lookback with or without Observation Shift1

In the UK, the recommendation from the Working Group is for a 5 Banking Days Lookback without Observation Shift1. Whilst this approach is the recommendation, each of Lookback with or without Observation Shift has benefits and limitations and either approach may be considered appropriate for market participants. In the US, the ARRC has made a decision to adopt Lookback without Observation Shift1 where interest is calculated on compound in arrears basis. They also determined that the basis risk between the two methods was minimal.

Compounded in arrears ? Lookback without Observation Shift1 vs Lookback with Observation Shift 2

? Key differences between Lookback without Observation Shift (Lag methodology) and Lookback with Observation Shift

Compounded in arrears Rate

Interest Amount

Lookback without Observation Shift1

Lookback with Observation Shift2

? Compounded rate is calculated based on no. of calendar ? Compounded rate is calculated based on no. of calendar days in

days in an interest period i.e., applicable SONIA for each an observation period i.e., applicable SONIA for each day within

day within a loan period is weighted based on no. of a loan period is weighted based on no. of calendar days in the

calendar days in the interest period.

observation period.

? Interest is calculated for the total no. of calendar days in an ? Interest is calculated for the total no. of calendar days in an

interest period

interest period

Negative Accrual

? There would be no scenario where the daily accrual may be ? If SONIA were to reduce sharply around bank holidays (even if

negative.

SONIA is not negative) there could be negative accrual on

certain days. However, total interest for that interest period will

not be negative.

1 Also known as `Lag' 2 Also known as `Interest Period Weighted Observation Shift'

Recommended Convention Lookback without Observation Shift1

1 Also known as `Lag'

Not for wider circulation

Lookback without Observation Shift1 - Overview

Below is an illustration of 5 Banking Days Lookback rate fixing for a SONIA referencing loan.

Rate used (T-5)

Interest Payment amount known

Rate known/ published (T-4) T-5 T-4 T

Interest Payment date (IP)

T-5

IP

How does 5 banking days Lookback work?

Every day of the interest period, 5 banking days prior rate is used.

For example ? if a loan is drawn effective 05Feb-19 (Tue), the applicable rate will be the rate

for 29-Jan-19 (Tue) which is published on 30Jan-19 (Wed). The same process is repeated

throughout the interest/ loan period.

Rate for Published on

28-Jan Mon

29-Jan Tue

0.7054

29-Jan Tue

30-Jan Wed

0.7036

30-Jan Wed 31-Jan Thu

0.7034

31-Jan Thu

01-Feb Fri

0.7034

01-Feb Fri

04-Feb Mon

0.7025

02-Feb Sat

-

03-Feb Sun

-

04-Feb Mon

05-Feb Tue

0.7051

05-Feb Tue

06-Feb Wed

0.7048

06-Feb Wed

07-Feb Thu

0.7066

07-Feb Thu

08-Feb Fri

0.7065

Loan Period - 05-Feb-19 to 12-Feb-19

Observation Date

Start Date

End Date

Daily RFR

Tue,29-Jan-19 Tue,05-Feb-19 Wed,06-Feb-19 0.7036

Wed,30-Jan-19 Wed,06-Feb-19 Thu,07-Feb-19 0.7034

Thu,31-Jan-19 Thu,07-Feb-19 Fri,08-Feb-19 0.7034

Fri,01-Feb-19 Fri,08-Feb-19 Mon,11-Feb-19 0.7025

Mon,04-Feb-19 Mon,11-Feb-19 Tue,12-Feb-19 0.7051

Comment

Use rate for 29-Jan published on 30-Jan Use rate for 30-Jan published on 31-Jan Use rate for 31-Jan published on 1-Feb Use rate for 1-Feb published on 4-Feb Use rate for 4-Feb published on 5-Feb

1 Also known as `Lag'

Lookback without Observation Shift2 - Formula

The Non Cumulative Compounded Rate1 is the recommended implementation approach as it better supports intra period events such as trading activity. Non Cumulative Compounded Rate - Lookback without Observation Shift2 Cumulative Compounded Rate - Lookback without Observation Shift2

Compounded Rate calculation

SStteepp11: ()

=

=1

1

+

? N

-1

N ?

* should be rounded daily to x decimal places (as defined in the

credit agreement)

Compounded Rate calculation

Step 1 db ( db)

=

=1

1

+

? N

-1

N ?

* should be rounded to x decimal places (as defined in the agreement)

Step 2 ()

=

?

N

* should not be rounded

Step 3: ()

N = - -1BD ?

* should not be rounded

ACR (in Step1) is rounded but UCR (in Step 2) and NCR (in Step 3) are not rounded to ensure compounded rate rounding is not duplicated and the interest

amount using Cumulative or Non Cumulative Compounded rate is the same.

Interest amount calculation

Step 4:

=

? [+ + ] ? N

=1

* should be rounded to 2 decimal places at the end of the period only

1 Preferred where rounding method is consistent to calculate the same interest amount as Cumulative Rate Method (see page 22)

2 Also known as `Lag'

Interest amount calculation

Step 2 =

? [+ + ] ? N

* should be rounded to 2 decimal places

Where

db = the number of Banking Days in the Interest Period

ri

= the interest rate applicable on Banking Day i in the Observation Period, as

published on the Banking Day immediately after Banking Day i

ni

= the number of calendar days for which ri applies in the relevant Interest Period,

(on most days, ni will be 1, but on a Friday it will generally be 3, and it will also

be larger than 1 on the Banking Day before a holiday).

tni = total number of ni as of the relevant Banking Day within the Interest Period.

N = market convention for quoting the number of days in the year.

BD = Banking Day for the specific currency only

i CAS

= series of whole numbers from one to db, each representing the relevant Banking Day in chronological order from, and including, the first Banking Day in the relevant Interest Period

= Credit Adjustment Spread (if applicable)

Lookback without Observation Shift1 - Worked example

Though the Cumulative and Non Cumulative Compounded Rate are different implementation approaches, if the same rounding conventions are used in both the methods, the interest amount will be identical. As illustrated below there is no difference in interest amount using Cumulative and Non Cumulative Compounded Rate

Lookback/Lag Days

5

Year Basis (N)

365

Margin Credit Adjustment

Spread

Loan Period - 15-Apr-19 to 15-May-19

2.00% 0.05%

Rounding Convention (Recommended)

No Rounding 16 dp or more

No Rounding 16 dp or more

As per Agreement 4 dp

Step 1: ACRi

No Rounding 16 dp or more Step 2: UCRi

No Rounding 16 dp or more Step 3: NCRi

No Rounding No Rounding No Rounding 16 dp or more 16 dp or more 16 dp or more 2 dp (at the end)

Step 4: Interest

Breaking down the Formula

ni

tni

ri

(N = 365)

Step 1: ACSi

Step 4: Interest

Observation Date (T-5)

Start Date (T)

No. calendar Cumulative

days in

Interest

Interest Period Period Days

Mon,08-Apr-19 Mon,15-Apr-19

1

1

Tue,09-Apr-19 Tue,16-Apr-19

1

2

Wed,10-Apr-19 Wed,17-Apr-19

1

3

Thu,11-Apr-19 Thu,18-Apr-19

5

8

Fri,12-Apr-19 Tue,23-Apr-19

1

9

Mon,15-Apr-19 Wed,24-Apr-19

1

10

Tue,16-Apr-19 Thu,25-Apr-19

1

11

Wed,17-Apr-19 Fri,26-Apr-19

3

14

Thu,18-Apr-19 Mon,29-Apr-19

1

15

Tue,23-Apr-19 Tue,30-Apr-19

1

16

Wed,24-Apr-19 Wed,01-May-19

1

17

Thu,25-Apr-19 Thu,02-May-19

1

18

Fri,26-Apr-19 Fri,03-May-19

4

22

Mon,29-Apr-19 Tue,07-May-19

1

23

Tue,30-Apr-19 Wed,08-May-19

1

24

Wed,01-May-19 Thu,09-May-19

1

25

Thu,02-May-19 Fri,10-May-19

3

28

Fri,03-May-19 Mon,13-May-19

1

29

Tue,07-May-19 Tue,14-May-19

1

30

Daily RFR (SONIA)

Unannualised/ Effective RFR

Compounding Factor

Annualised Cumulative Compounded RFRi

(ACRi)

Unannualised Cumulative

Non Cumulative

Compounded RFRi (UCRi)

Compounded RFRi (NCRi)

Principal

RFR Interest using Non Cumulative Compounded

Rate

Credit Adjustment

Spread Interest

0.70790% 0.0000193945205 1.0000193945206

0.707900% 0.0000193945205 0.7079000000% 100,000,000

1,939.45

136.99

0.70720% 0.0000193753425 1.0000387702388

0.707600% 0.0000387726027 0.7073000000% 100,000,000

1,937.81

136.99

0.70810% 0.0000194000000 1.0000581709909

0.707700% 0.0000581671233 0.7079000000% 100,000,000

1,939.45

136.99

0.70750% 0.0000969178082 1.0001550944370

0.707600% 0.0001550904110 0.7075400000% 100,000,000

9,692.33

684.93

0.70740% 0.0000193808219 1.0001744782647

0.707600% 0.0001744767123 0.7076000000% 100,000,000

1,938.63

136.99

0.70820% 0.0000194027397 1.0001938843898

0.707700% 0.0001938904110 0.7086000000% 100,000,000

1,941.37

136.99

0.70810% 0.0000194000000 1.0002132881512

0.707700% 0.0002132794521 0.7077000000% 100,000,000

1,938.90

136.99

0.70840% 0.0000582246575 1.0002715252273

0.707900% 0.0002715232877 0.7086333333% 100,000,000

5,824.38

410.96

0.70870% 0.0000194164384 1.0002909469377

0.708000% 0.0002909589041 0.7094000000% 100,000,000

1,943.56

136.99

0.70920% 0.0000194301370 1.0003103827279

0.708100% 0.0003104000000 0.7096000000% 90,000,000

1,749.70

123.29

0.70870% 0.0000194164384 1.0003298051928

0.708100% 0.0003298000000 0.7081000000% 90,000,000

1,746.00

123.29

0.70960% 0.0000194410959 1.0003492527004

0.708200% 0.0003492493151 0.7099000000% 90,000,000

1,750.44

123.29

0.71070% 0.0000778849315 1.0004271648335

0.708700% 0.0004271616438 0.7109500000% 90,000,000

7,012.11

493.15

0.70970% 0.0000194438356 1.0004466169748

0.708800% 0.0004466410959 0.7110000000% 90,000,000

1,753.15

123.29

0.71090% 0.0000194767123 1.0004661023857

0.708900% 0.0004661260274 0.7112000000% 90,000,000

1,753.64

123.29

0.71030% 0.0000194602740 1.0004855717302

0.708900% 0.0004855479452 0.7089000000% 90,000,000

1,747.97

123.29

0.71070% 0.0000584136986 1.0005440137929

0.709200% 0.0005440438356 0.7117000000% 90,000,000

5,264.63

369.86

0.70980% 0.0000194465753 1.0005634709474

0.709200% 0.0005634739726 0.7092000000% 90,000,000

1,748.71

123.29

0.70940% 0.0000194356164 1.0005829175153

0.709200% 0.0005829041096 0.7092000000% 90,000,000

1,748.71

123.29

Margin Interest

5,479.45 5,479.45 5,479.45 27,397.26 5,479.45 5,479.45 5,479.45 16,438.36 5,479.45 4,931.51 4,931.51 4,931.51 19,726.03 4,931.51 4,931.51 4,931.51 14,794.52 4,931.51 4,931.51

30

55,370.96 3,904.11 156,164.38

Total Interest

7,555.89 7,554.25 7,555.89 37,774.52 7,555.07 7,557.81 7,555.34 22,673.70 7,560.00 6,804.49 6,800.79 6,805.23 27,231.29 6,807.95 6,808.44 6,802.77 20,429.01 6,803.51 6,803.51

215,439.45

1 Also known as `Lag'

Cumulative Rate Method Cumulative Rate vs Non Cumulative Rate Method

55,370.96 0.00

3,904.11 156,164.38 215,439.45

0.00

0.00

0.00

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download